Riding the Crest of the CRE Wave Without Falling Off
- Feb 19, 2020
The economy is robust, interest rates are at historic lows, and demand for commercial real estate continues to be strong at the macro level. Still, investors and developers should be aware of subtle shifts in micro-level markets and be prepared to adjust their activity.
A variety of industries are driving demand for CRE, including financial firms, tech companies, and companies in the hybrid fintech space. But every cycle eventually comes to an end, and we may already be seeing signs of stress.
The New York City luxury residential housing market, which has been a key growth driver, for example, has taken some significant hits recently, even before the Coronavirus crisis struck. Contracts signed for homes in Manhattan priced at $4 million or more fell 16 percent in 2019, according to a recent Bloomberg report, and the total value of deals in that segment slid to $7.65 billion, the lowest level since 2012, noted Bloomberg, citing a report by luxury brokerage Olshan Realty Inc.
Some reports note that the high-end market in New York City, where pricing is already off by as much as 25 percent from the levels set in 2014 and 2015, could face drops of another 10 percent or more. Even in the broader, citywide condo market, more than 25 percent of the 16,242 new condos built since the start of 2013 remain unsold in the third quarter of last year, according to a report from streeteasy.com, a listing site.
Demand for the luxury segment in this market has been shrinking thanks to a combination of federal tax laws that limit deductions for state and local taxes, and a pullback in condo-hungry, cash-rich overseas buyers. But even though the luxury market is already in saturation territory, and the broader condo market is also showing some weakness, inventory in the important New York City market has continued to march ahead, setting the stage for additional pricing pressures. The New York Building Congress, for example, estimated that construction spending in the city reached $59.3 billion in 2019, and it projected 2020 construction to reach a still lofty $56.4 billion.
Rethinking and Repositioning
Even though conditions are undergoing some change, developers, of course, can’t easily pull the plug on in-progress projects. But in a falling luxury market, they can take some steps to limit the pain, like swapping out plans for high-end finishes with something more cost effective, or any other of the numerous methods used by value engineers.
An advanced example of this latter approach is already visible in the heavily built-up Jersey City market, which is seeing growth in the development of micro-units, or apartments in the 200- to 300-square-foot range that feature communal spaces throughout the property, like a lounge, cafe, laundry room, and a gym and roof deck. Strategic moves, like taking advantage of millennial demand by positioning new projects as rentals instead of condos, may also help. Finally, if the ground hasn’t been broken yet on a planned project, a developer may—if investors agree—want to consider sitting on the property until demand catches up again.
Multifamily developers and investors can still find some bright spots, particularly in the corridor extending from just outside of New York City to Philadelphia, and just west of New Jersey in Pennsylvania’s Lehigh Valley market. There’s no shortage of deal flow or demand in those markets, particularly for upscale townhouses in the sub-$500,000 price point segment. In-demand amenities will depend on the project, but these townhouse communities will often feature a clubhouse, a community pool, and a well-equipped gym.
Investors, along with lenders, are also expanding their sights to non-traditional assets beyond the residential and office markets, taking a closer look at repair-truck, gas station and other facilities. There may be no asset class that can reliably claim to be consistently recession proof, but investors and developers who maintain high-quality, diversified portfolios have the best chance at riding out the ups and downs of the commercial and multifamily real estate markets.
Brian Foley leads Procida Funding & Advisors’ Originations department.